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June 1, 2010

Rule 605 Likely Coming to Options

By Peter Chapman

The Securities and Exchange Commission may require market centers in the options industry to calculate and disseminate execution-quality statistics.

In a speech last week at the annual Options Industry Conference, Jamie Brigagliano, a deputy director in the SEC's Division of Trading and Markets, told attendees "it would not be surprising to me if the [SEC] staff were to recommend that the commission consider making options subject to Rule 605 execution-quality disclosure requirements."

Rule 605, one of 13 rules that make up Regulation NMS, requires market centers on the cash equities side to publish monthly such indicators of execution quality as speed, level of price improvement and effective spread.

The statistics are used by brokers handling customer orders to help them decide where to route those orders.

The rule was instituted in 2001 in the cash equities market following the elimination of NYSE Rule 390, which gave broker-dealers expanded powers to internalize orders. The SEC was concerned that a surge in internalization could lead to a decline in the quality of fills.

The rule was not applied to the options market for two reasons, Brigagliano said. First, in 2000, when the SEC was mulling the idea of including options in Rule 605, the options industry did not have a consolidated national best bid and offer, essential to calculating any statistics. Second, it was believed that options contracts had too many series associated with them to make a rule practical.

At the conference, Brigagliano said the hurdles of 2000 are no longer present. The Options Price Reporting Authority now disseminates a consolidated NBBO. Also, "vendors have developed methodologies for categorizing options execution-quality statistics that would likely provide useful information," Brigagliano said.

Although the SEC decided against including options in Rule 605, it quietly encouraged the exchanges to voluntarily produce execution quality statistics. In recent years, the options exchanges have posted such statistics on their websites.

Brigagliano did not say the SEC would definitely propose the expansion of Rule 605 to options, but industry executives are taking it that way.

"I interpreted [Brigagliano's] comments to mean 605 is coming to the options world."

Kevin Murphy, Citi's head of U.S. option electronic execution, told OIC attendees.

Retail brokers speaking at the conference generally agreed that transparency into the execution process was a positive.

"It all comes down to customer confidence," said Randy Frederick, director of trading and derivatives at Charles Schwab. "They have to be confident that the marketplace is fair. They have to be confident that we have their best interests in mind; that we are routing to the best place and they are getting instant executions; and that they couldn't have gotten better fills elsewhere."


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